BUZ LIVINGSTON: Four most dangerous words in finance

By Buz Livingston

Published: Thursday, May 2, 2013 at 05:01 PM.

No country can support an endless growth in its deficit, true dat. But the “Austerity Today, Austerity Tomorrow, and Austerity Forever” crowd woke up recently and found their intellectual argument shattered. Two Harvard professors, Carmen Reinhart and Ken Rogoff, ostensibly linked high debt, as measured by percent of Gross Domestic Product with low economic growth. Representative Paul Ryan used their study as justification for his 2013 proposed budget and cited their report specifically.

The current government sequestration is a corollary of Reinhart and Rogoff’s hypothesis. When our legislators figured out the FAA cuts meant flight delays, they reversed FAA sequestration. Conversely, while volunteering at the E.O. Wilson Biophila Center, one of my Florida Trail Association compadres sang the sequestration blues; his wife can’t get an Eglin job due to cost control measures so he’s holding off buying a home until the dust settles.

Reinhart and Rogoff made some curious omissions. Crucially for the United States, they excluded data from Canada, our largest neighbor and leading trade partner in addition to underweighting other countries. More importantly, they made a simple but fundamental Excel mistake — not a math error as Excel does not make math errors. Excel is the logic behind the math. Their spreadsheet incorporated a bad formula, a simple but far-reaching mistake. At the University of Georgia, in the pre-Excel epoch, Dr. A.A. Fleming adjudicated a Plant Genetics answer partially correct if you used correct logic but made a simple math error.

A Cliffs Notes version of their premise was once a country’s debt exceeded 90 percent of its Gross Domestic Product, negative growth loomed. GDP is what a country produces (consumer and government spending, business capital investments plus net imports); think of GDP as a country’s earnings. Their data showed a negative .1 percent growth or recession for countries with over 90 percent debt to GDP. When run correctly, the statistics show a 2.2 percent GDP growth or recovery. Some may lament it’s a mild recovery but a recovery nonetheless, and the rationale behind Rogoff and Reinhart’s argument collapses — no partial credit.

Economists, even Ivy Leaguers, have dismal records in crisis prediction. Proverbs reminds us pride goes before destruction, a haughty spirit before a fall. The good doctors foresaw a looming economic calamity with their book, “This Time is Different." Legendary financier Sir John Templeton once said the four most dangerous words for investors are “This Time is Different."

Reinhart and Rogoff thumbed their noses at an icon and let the dogs of austerity wreak havoc around the world. The data does not demonstrate high debt levels cause low growth; maybe low growth leads to high debt levels. The International Monetary Fund noted some emerging market economies spurned austerity and per-capita GDP growth increased. Sir John’s warning for investors, either personal or governmental, rings true today.

To their credit, Reinhart and Rogoff realize America needs compromise to reach logical, long-term solutions. Republicans politicians have a dilemma; if they compromise on taxes then assuredly a Tea Party challenge looms. Democrats should remember Jimmy Carter reduced cost of living adjustments, too. Few realize the deficit, as percentage of GDP, has dropped since President Obama took office in 2009 from 10 percent to around 5 percent currently.

No country can support an endless growth in its deficit, true dat. But the “Austerity Today, Austerity Tomorrow, and Austerity Forever” crowd woke up recently and found their intellectual argument shattered. Two Harvard professors, Carmen Reinhart and Ken Rogoff, ostensibly linked high debt, as measured by percent of Gross Domestic Product with low economic growth. Representative Paul Ryan used their study as justification for his 2013 proposed budget and cited their report specifically.

The current government sequestration is a corollary of Reinhart and Rogoff’s hypothesis. When our legislators figured out the FAA cuts meant flight delays, they reversed FAA sequestration. Conversely, while volunteering at the E.O. Wilson Biophila Center, one of my Florida Trail Association compadres sang the sequestration blues; his wife can’t get an Eglin job due to cost control measures so he’s holding off buying a home until the dust settles.

Reinhart and Rogoff made some curious omissions. Crucially for the United States, they excluded data from Canada, our largest neighbor and leading trade partner in addition to underweighting other countries. More importantly, they made a simple but fundamental Excel mistake — not a math error as Excel does not make math errors. Excel is the logic behind the math. Their spreadsheet incorporated a bad formula, a simple but far-reaching mistake. At the University of Georgia, in the pre-Excel epoch, Dr. A.A. Fleming adjudicated a Plant Genetics answer partially correct if you used correct logic but made a simple math error.

A Cliffs Notes version of their premise was once a country’s debt exceeded 90 percent of its Gross Domestic Product, negative growth loomed. GDP is what a country produces (consumer and government spending, business capital investments plus net imports); think of GDP as a country’s earnings. Their data showed a negative .1 percent growth or recession for countries with over 90 percent debt to GDP. When run correctly, the statistics show a 2.2 percent GDP growth or recovery. Some may lament it’s a mild recovery but a recovery nonetheless, and the rationale behind Rogoff and Reinhart’s argument collapses — no partial credit.

Economists, even Ivy Leaguers, have dismal records in crisis prediction. Proverbs reminds us pride goes before destruction, a haughty spirit before a fall. The good doctors foresaw a looming economic calamity with their book, “This Time is Different." Legendary financier Sir John Templeton once said the four most dangerous words for investors are “This Time is Different."

Reinhart and Rogoff thumbed their noses at an icon and let the dogs of austerity wreak havoc around the world. The data does not demonstrate high debt levels cause low growth; maybe low growth leads to high debt levels. The International Monetary Fund noted some emerging market economies spurned austerity and per-capita GDP growth increased. Sir John’s warning for investors, either personal or governmental, rings true today.

To their credit, Reinhart and Rogoff realize America needs compromise to reach logical, long-term solutions. Republicans politicians have a dilemma; if they compromise on taxes then assuredly a Tea Party challenge looms. Democrats should remember Jimmy Carter reduced cost of living adjustments, too. Few realize the deficit, as percentage of GDP, has dropped since President Obama took office in 2009 from 10 percent to around 5 percent currently.

Focusing on structural deficits should be a priority, and we need resolutions-based, sound theory not a bad Excel spreadsheet.

Buz Livingston, a certified financial planner, has the only investment management firm in the entire world headquartered in Blue Mountain Beach. He helps clients along Florida’s Emerald Coast and around the country with financial decisions. For more information, call 850-267-1068 or visit www.livingstonfinancial.net.